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Preferred stock is as much an equity security as common stock, but behaves more like a debt security because it has a fixed rate of return. Because the dividend rate is fixed, the price of preferred stock tends to fluctuate along with interest rates like bonds rather than in response to the company's business performance, except in the most dramatic circumstances.
In addition to fixed-rate, the investor may also purchase prefered stock with an adjustable rate of return. Adjustable-rate preferred stock is usually linked to a major interest rate indicator, like the discount rate or the money market rate, and the rate of return may be adjusted according to its host indicator as often as semianually.
Unlike debt securities, preferred stock has no maturity date, and may be held by investors indefinitely; and unlike common stock, preferred stock confers no voting rights to its shareholders.
There are two substantial advantages to owning preferred stock rather than common stock:
- First, preferred stock shareholders have priority over common stock shareholders with dividend payments. If a company is on shakey ground and having difficulty paying its dividends, this is a very useful feature.
- Second, preferred stock shareholders have priority over common stock shareholders when the company goes bankrupt. After general creditors are reimbursed, all preferred shareholders receive compensation for their investments before any common shareholder.
Because of these features, preferred stock is the more conservative equity security, and appropriate for more cautious investors seeking income rather than growth.
Preferred shares may be either straight, as described above, cumulative, convertible, participating or callable.